Mandated Madness

In all the fuss about the House Health Care “Reform” bill, we have failed to talk about one of the biggest drivers of health insurance costs in the nation today: Insurance mandates.

What insurance mandates do is force these small risk pools together in a negative way: When the risk pool for broken leg is combined with the risk pool for cancer, the risk pool is not more efficient, it is simply more risky. If the likelihood of a broken leg in a given year is 2%, and the likelihood of being diagnosed with cancer is also 2%, combining those risk pools does not result in a larger risk pool of 2%. Cancer and a broken legs are generally exclusive; that is to say, people who get cancer are unlikely to suffer a broken leg at the same time. So the risk index has grown from 2% to a combined 3.99% (after all, some people who break their legs will also develop cancer). The more mandates that are added, the more the insurer is required to cover, the greater the cost of the risk pool.

The financial risk pool is even more complex, but I’ll try to simplify it. Cancer is actually a lot less likely than broken bones, so let us imagine an insurer who insures only cancer and broken bones with 10,000 customers who pay no deductible and have no co-pay. In that pool of customers (risk pool), cancer has a risk index of 0.1% (10 people wll get cancer in a year) and a broken bone has a risk index of 2% (200 people will break a bone in a year). Hypothetically, the financial burden of an average broken bone is $1,500, meaning that the average person in the risk pool is a $30 risk to the insurer ($,1500*0.02=$30). Meanwhile the financial burden of cancer is $50,000, so the average person has a financial risk of $50 ($50,000*0.001). Remember, this is a gross over-simplification intended to illustrate a point.

In this example, the risk pool has a financial risk of $80 per year. Add the administrative cost of maintaining the insurance plan, billing the customers and working with doctors, and the cost is probably about $90 per person to the insurer. Right now, average insurance industry profits are about 2.2%. So to effectively cover this group of 10,000 people and maintain profitability, the insurer must charge $91.98 per customer. The more mandates that are added, the more the insurer is required to cover, the greater the cost of the risk pool.

Hypothetically, each customer is paying about a 13% premium for having insurance to cover the administration and insurance company profits, but this is minimal compared to the potential savings in a health-related emergency: If they break a bone, they are actually saving about 94% on the cost of their treatment. Even adding a $100 co-pay for the broken bone assures them an 87.8% savings for treatment. For cancer, the savings are even greater: With no co-pay or deductible, the customer saves 99.8% of the cost. Add a $3,000 deductible and the customer still saves 93.8% on the cost of their treatment. If the customer does not use their insurance, they have lost their $91.98, but at least they are covered if a covered medical issue arises.

Insurance mandates, however, force insurance companies to pay for treatment for common diseases or diagnostics. Depending on the state, mandates require coverage for things like mammograms, prostate examinations, flu shots, substance abuse counseling and more. The cost for such programs might be relatively low, but the risk index is much greater. The risk index for $10 flu shots, for exmaple, might be 40%, raising the risk of each customer another $4 and increasing premiums an average $4.09. Substance abuse counseling might cost $5,000 and have a risk index of 1%, with a resulting cost of $50 and a premium increase of $51.10. That does not account for any additional administrative costs. Mammograms might add another $45 and prostate examinations $45 more.

Now, our plan that cost $91.98 per year has grown to $237.17 per year, more than doubling its overall cost, and we have not even accounted for any increases in administration. Now add ever greater mandates, and costs inescapably rise.

Let’s add another wrinkle: These 10,000 customers are split between two states, with 3,000 people in one state and 7,000 in the other. Each state has mandated coverage for the six items listed above, but the larger state also mandates coverage for gall bladder surgery at an average cost of $10,000 per patient. Now the calculations become more complex:

In the smaller state, the make-up of the risk has changed. In this state, there are problems with radon and so cancer incidence is slightly greater, say 0.11%, but all other risk remains the same. This results in a new risk rate of $229 per customer and an average premium of $244.26, a relative increase in cost. In the larger state, the cancer risk index has dropped to just under 0.08%. Gall bladder surgery isn’t very likely, just 0.5% of customers become patients, but it adds up: The financial risk pool is now greater by $50 per customer. So customers in the larger state face even higher premiums: With costs now totaling $274, average annual premiums in the larger state top $280.03.

So we see that individual state mandates have radically increased the overall cost of health coverage while only increasing the effect of that coverage by a small amount. Without mandates, the cost to these 10,000 customers was just $919,800 for coverage. Adding mandates across the board more than doubled the overall cost of the system, to $2,371,700. Adding an individual state mandate further expanded the costs to $2,692,990.

This is what has been happening to our health care system for roughly the last 30 years: Ever increasing mandates with completely differing risk pools in every state making the cost of providing insurance ever greater, even in states with relatively low mandate levels.

The health care debate is not going to be solved at the national level. Just like in the individual states, the Federal Government can impose greater and greater mandates on insurers. Instead, we must focus on fixing these issues locally. Car insurance offers one solution. No, the solution is not to allow the purchase of insurance “across state lines.” This will only increase the complexity of the system and eventually require Federal Interstate Commerce interference. Rather, most states require car insurance to cover a certain minimum coverage (“Liability” Insurance) and allow individuals to purchase greater coverage at their own discretion (“Comprehensive” Coverage).

This way, people can pick-and-choose what coverage they want and pay accordingly. Risk pools are not forced together in ways that unfairly increase the financial burden on those buying premiums. Insurers can offer lower-risk, lower-cost catastrophic-coverage plans to those who cannot afford or do not want coverage for more expensive health maintenance items.

The problems of and solution to our health care mess is found in our Federal system, but an effective solution will not come from the Federal government. It will come from voters who find and elect state representatives who will fix the nightmare that is our individual state mandate problem.